Sunday, January 20, 2008

A Perfect Financial Storm?

The downgrade of AMBAC’s financial-strength rating, and the possibility of downgrades of other bond insurers, including MBIA, could be the beginning of a perfect financial storm. These companies jumped onto the sub-prime lending train, along with major Wall Street financial institutions, to profit from the practice of providing credit to less than creditworthy customers, and with the encouragement of Washington to bring the American dream of homeownership to everyone. While the latter is a nice politically correct thought, greedy investors went along for the ride too, buying up “investment property” and homeowners indulged in the practice of using their homes as a piggy bank to buy luxury items. They used cheap money (thanks to the Federal Reserve) and exotic no money down, no interest payment loans, the repayment of which was dependent on future appreciated real estate values. This pot was mixed by mortgage brokers who could now sell off these loans in neat packages through Wall Street firms, with guarantees from the likes of AMBAC and MBIA. Which brings us to the point of this post.

The bond insurers strayed from their main businesses in their greedy pursuit of a piece of the action, and that is their role insuring new municipal bonds. Cities and counties are dependent on reasonably priced debt to make investments in education and infrastructure. The bond insurers made it possible for many municipal bonds to attain AAA ratings, keeping their borrowing costs relatively low. Whether the bond insurers could actually cover a financial Armageddon, even without the CDO mess, is another issue, but so much of finance and investment is really about confidence, and this is what AMBAC and MBIA insurance conveyed.

Now, we are on the edge of a recession or we are already in one, and how deep it will be and how long, no one can tell, even by our Federal Reserve Chairman, Mr. Bernanke (who has not yet acknowledged we are in a recession). Municipal revenues are already under pressure due to falling property values. Add to that mix a severe recession, uncontrolled energy costs ( and their inability to raise capital, or at least at a reasonable cost without the bond insurers, and one has the perfect financial storm for dramatically decreased spending, loss of jobs, and lack of confidence in the financial system all of which just feeds upon itself in a deepening crisis.

Our chicken little representatives on both sides of the isle are clucking an economic stimulus package such as throwing a few hundred dollars at everyone to spend immediately. Maybe we’ll borrow the money from China or one of the other BRIC countries. Why not, we seem to be content to mortgage our future for immediate gratification.

It seems that a better thought out plan is needed to fix the present structural deficiencies of the financial system. It also wouldn’t hurt to find sounder ways to fund this beginning with reducing the financial hemorrhaging of the Iraq war, not to mention getting our troops home. The “guns and butter” approach has failed us before.